Methods of Forecasting the Behavior of the Forex Market

Businesses which are involved in global trading need to be in a position to predict forex market behavior. This is essential for them when concluding deals / arranging for payments to protect themselves from the possible adverse outcomes of forex market behavior or gain from the situation. Being a complex exercise, guess work is not a tool at all and one has to use a scientific basis to predict forex market behavior.

This article on the forecast of behavior of the Forex Market will educate you on two methods of analysis. Though, both of them (Technical and Fundamental analysis) have vast difference between their approaches, their goal is the same. They are very effective in predicting the rise, movement or price of the forex market behavior and/or trends. To get the best outcome, fundamentalists suggest combining both of them for better results.

There is no judgment possible on which of the above 2 methods is more reliable. They vary in their approaches and use different parameters to predict the price or a price movement. In essence, we can say that while a Technical analyst will focus on what will be the outcome i.e. the price or the movement expected, a Fundamental Analyst will lay emphasis on the “Why” of the price or the movement expected. A Technical Analyst would believe that over and above the fundamental analysis, certain other factors need to be taken into account before coming to a conclusion. A judicious mix of the two approaches is what is really sound as it is important to know the cause and also the effect i.e. the price or the movement expected taking into account all factors affecting it.

Let’s try and understand how these two approaches work:

Technical Analysis:

The method focuses on understanding the prevailing market trends and tries to pinpoint any reversal of this trend and predict how the forex market is likely to behave in the future. It is more statistical in nature in the sense that this method relies heavily on historical data on prices and volumes traded and using charts to understand and interpret the behavior. Many tools are available for making such analysis like Indicators, Number Theory, Waves, Gaps, and Trends etc.

A technical analyst prefers not to waste his time on finding out how the market ought to have behaved and why it did not – he would look at only what has happened and what is the take-out from that behavior. This method believes that the historical movements of the prices do tell a story that needs to be understood.

This method also believes that such study of price movements is more useful when we are talking about a situation where price movements are caused by free market situation i.e. where demand and supply situation determine the rate and not where exchange rates are fixed artificially. (Malaysian Ringgit ( MR) was once pegged to the United Stated Dollar (USD) by the Malaysian Government at 3.76 MR to a USD). On top of all this, this method tries to understand the “market sentiment” or the emotional reaction of the market as opposed to the sentiments of the individual participants in the market.

In essence, Technical Analysis is underscored by three basic assumptions:

That the market discounts everything: that is to say all the happenings in the economy – let’s say global economy – be they political events, statements by economic gurus , security situation, crop failures or the collapse of a bank – everything affects the forex market and has affected the prices prevailing in the market.

Prices move in trends: which means that there is a pattern always to the price movements which need to be studied and that they do tell us something about the existing trends and allow us to make a prediction.

History repeats itself: that is, mass thinking does not change dramatically over periods of time and the “wave” of mass psychological thinking moves in a familiar pattern. Only, the same needs to be understood and applied in practice.

Fundamental Analysis:

As the name suggests, this method of analysis focuses on the “fundamental” factors that are known to affect / ought to be affecting forex market rates. This method therefore is a bit traditional in approach and is typically theoretical in nature. For instance, typically, a Fundamental Analyst when asked to predict the forex market rates, would look at existing and expected interest rates, GDP growth rates, inflationary trends, weather changes affecting agricultural output, international trade balances, exchange rate policies of the countries involved , capital market status etc. before saying “I believe given these indicators, the forex market ought to be behaving this way” and would conclude whether a currency is likely to appreciate or depreciate vis- a- vis the other one. Not surprisingly, when the market rate determined is at variance with the prediction, a fundamental analyst looks flummoxed.

This kind of analysis fails to take into account that there is also something called market sentiment – simply because such a factor is not “fundamental” to the analysis because it is not predictable and not driven by rationale.

Conclusion:

Having understood both the approaches, we can only say that both methods have their own merits and demerits.

However, smart forex market operators prefer to use a good mix of these 2 methods, apply their own judgment and take calls on how the market is likely to behave and take actions as deemed fit for their business.